Crowdfunding and lean startups

Crowdfunding is hot. According to Crowdsourcing.org, in 2012, more than US$2.7 billion was raised through crowdfunding platforms; in 2013 the amount is expected to increase to US$5.1 billion. That crowdfunding is hot was also confirmed at a recent sold out MaRS Best Practices event featuring Brian Meece, the CEO and co-founder of crowdfunding platform RocketHub.

According to Brian, crowdfunding can be defined as “an event that harnesses networks for funds, awareness and feedback.” Historically, crowdfunding can be seen as part of a long-term trend of “democratizing innovation,” as described by Eric Von Hippel in his 2005 book by the same name. In the world of funding, crowdfunding fits somewhere in between “The Long Tail” as described by Chris Anderson in 2004 and microfinance as done by Grameen Bank and Kiva.

The Pebble effect

Considering that current security regulations prevent equity from being raised through crowdfunding events in Canada and the United States, what exactly is the appeal of crowdfunding to the current class of entrepreneurs?

One word describes it all: Pebble.

When Pebble Technology was unable to raise venture capital funding to develop and market their smartwatch, they decided to run a pre-sales campaign on a crowdfunding platform in an attempt to obtain orders totalling $100,000 so that they could begin production. The campaign launched in April 2012 and reached its initial funding target within days. When the campaign wrapped up, 68,928 buyers had placed orders for a total value of $10,266,844—more than 100 times the initial funding target.

As other entrepreneurs struggle to raise risk capital from traditional sources, such as angel and venture capital investors, the Pebble campaign has shown that pre-sales through a crowdfunding platform can be a very attractive alternative to raising the capital required to get commercial operations started. After all, Pebble’s founder raised more money than he was looking for and did so without having his ownership share watered down.

Is crowdfunding for you?

In his talk, Brian presented some statistics that should cause people to think twice before launching a crowdfunding campaign.

A typical crowdfunding campaign attracts between 50 to 500 funders.

On average, each transaction is $75.

On average, overall campaign revenue ranges from $3,750 to $37,500.

In other words, the typical crowdfunding campaign is very different from the Pebble campaign. Lean startups that are hoping to use crowdfunding as a way to validate their solutions and business models should ask a few critical questions to determine whether crowdfunding is, in fact, the right way to go.

Deal size: If the average transaction is $75, does that fit with what you are offering? What kind of goods and incentives can you put together to entice people to place an order?

Network size: Do you have enough potential customers in your network? Do you have well-connected “evangelists” in your network who can take your campaign to their own networks so that you can break outside the typical 50 to 500 backers if required?

Project type/quality: Does your project grab people emotionally? Do you have an eager fan group like the cult TV show “Veronica Mars” had? (Over 91,000 backers contributed $5.7 million to fund the making of a “Veronica Mars” movie.) Does your project have a feel-good factor that travels well through social networking sites?

Risks: Do you know enough about your product and the timelines and costs involved in developing and manufacturing the volumes you are seeking so that you can get the price right and manage the expectations of the backers?

If your responses to these questions are positive, Brian offered further advice in the form of a project checklist to make sure that you’re truly ready for a crowdfunding campaign.

Does your project have a catchy title?

Has a financial goal been established?

Has a time frame for reaching the financial goal been set?

Do you have quality photos of the goods/incentives?

Do you have a two- to three-minute-long video that promotes your project in an authentic manner?

Do you have audio that echoes the video storyline?

Do you have a written description of your venture?

Have you calibrated the rewards that you will offer potential backers?

This checklist alone does not ensure success. Once a crowdfunding campaign is launched you need to have a game plan in order to engage with potential backers, to get your first “wins,” to build and maintain energy in the campaign and to communicate actively with potential backers throughout the campaign.

Crowdfunding for lean startups

While lean startups may plan to use crowdfunding as a way of validating their solution and business model, they must resist the temptation to jump in too early in the customer development process. Crowdfunding should not be considered until some fundamental pieces are in place.

First, the customer problem must have been validated. Without the insights generated from validating the customer problem properly, there are too many unknowns to run an effective crowdfunding campaign.

Second, a minimum viable product solution must have been designed and priced properly, a process that may involve negotiating with suppliers. Some successful crowdfunders have encountered supply chain issues when their campaigns finished, leading to delivery problems, unhappy customers and bad publicity.

Only when these two points have been resolved would we recommend that a startup consider a crowdfunding campaign.

Watch this space

Meanwhile, we are waiting for both Canadian and American regulators to move forward with new market rules that will allow crowdfunding platforms to facilitate the raising of equity and debt for startups and projects. The United States Securities and Exchange Commission was supposed to issue new rules earlier this year, but the new rules have been delayed and are not yet known. The Ontario Securities Commission has engaged in a consultation process, but has not yet issued new rules or a timeline for when such rules should be expected.

For more information about crowdfunding and the potential crowdfunding exemption being considered by the Ontario Securities Commission, see the following resources:

Jon E Worren is the senior director of venture and corporate programs at MaRS. He is responsible for identifying new innovation and entrepreneurship practices and creating tools and resources that help both intrapreneurs and entrepreneurs to be more successful. Jon is also an instructor in Entrepreneurship at University of Toronto School of Continuing Studies. He holds a Master of Science in Media & Communication from London School of Economics and a Master of Science in Business and Economics from the Norwegian School of Management. See more…